Question

Consider the following information for Evenflow Power Co., Debt: 5,000 6.5 percent coupon bonds outstanding, $1,000 par value, 17 years to maturity, selling for 102 percent of par; the bonds make semiannual payments. Common stock: 105,000 shares outstanding, selling for $59 per share; the beta is 1.17. Preferred stock: 18,000 shares of 6 percent preferred stock outstanding, currently selling for $105 per share. Market: 8.5 percent market risk premium and 5 percent risk-free rate. Assume the company's tax rate is 34 percent. What is the company's WACC?

Answer 1

Answer:

WACC 10.07765%

Explanation:

We solve for the cost of debt by solving for the discount rate which makes the future coupon payment and maturity of the bond equal to 1,020

This is solved using excel or a financial calculator

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C 32.50

time 34

rate 0.03153274

$32.5 \times \frac{1-(1+0.03153274)^{-34} }{0.0315327401919093} = PV$

PV $672.0015

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity   1,000.00

time   34.00

rate  0.03153274

$\frac{1000}{(1 + 0.03153274)^{34} } = PV$  

PV   348.00

PV c $672.0015

PV m  $347.9985

Total $1,020.0000

annual cost of debt:

0.031532 x 2 = 0.063064 = 6.31%

debt outstanding:

5,000 bonds x $ 1,000  x 102/100 = 5,100,000

equity:

105,000 shares x $59 each = 6,195,000

For  the equity we solve using CAMP

$Ke= r_f + \beta (r_m-r_f)$

risk free = 0.05

market rate = 0.09

premium market = (market rate - risk free) 0.085

beta(non diversifiable risk) = 1.17

$Ke= 0.05 + 1.17 (0.085)$

Ke 0.14945

Now we solve for the WACC

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

D  5,100,000

E  6,195,000

V  11,295,000

Equity weight 0.5485

Debt Weight 0.4515

Ke 0.14945

Kd 0.0631

t 0.34

$WACC = 0.14945(0.5485) + 0.0631(1-0.34)(0.4515)$

WACC 10.07765%